I am Forbes' Opinion Editor. I am a Senior Fellow at the Manhattan Institute for Policy Research, and the author of How Medicaid Fails the Poor (Encounter, 2013). In 2012, I served as a health care policy advisor to Mitt Romney. To contact me, click here. To receive a weekly e-mail digest of articles from The Apothecary, sign up here, or you can subscribe to The Apothecary’s RSS feed or my Twitter feed. In addition to my Forbes blog, I write on health care, fiscal matters, finance, and other policy issues for National Review. My work has also appeared in National Affairs, USA Today, The Atlantic, and other publications. I've appeared on television, including on MSNBC, CNBC, HBO, Fox News, and Fox Business. For an archive of my writing prior to February 2011, please visit avikroy.net. Professionally, I'm the founder of Roy Healthcare Research, an investment and policy research firm. In this role, I serve as a paid advisor to health care investors and industry stakeholders. Previously, I worked as an analyst and portfolio manager at J.P. Morgan, Bain Capital, and other firms.

Mitt Romney's Promising Plan for Entitlement Reform

Yesterday, at a speech before the Americans for Prosperity in Washington, Mitt Romney delivered a significant address on fiscal issues. In the speech, Romney outlined his plans for reforming Social Security, Medicaid, and—most importantly—Medicare. Romney’s Medicare plan is vaguely to the left of Paul Ryan’s Path to Prosperity, both for good and for ill. Critical details are still missing. But politically, the plan allows Romney to justly claim that he is helping to lead the fight against runaway health-care spending. And that, in turn, may help Romney get a second look from the skeptical Republican base.

Simple fixes for Social Security and Medicaid

Social Security is one of the simplest government programs there is, and fixing it is, from a policy standpoint, quite easy. (The politics, obviously, are a different matter.) “I believe we can save Social Security with a few commonsense reforms,” said Romney. “First, there will be no change for retirees or those near retirement. No change. Second, for the next generation of retirees, we should slowly raise the retirement age. And, finally, for the next generation of retirees, we should slow the growth in benefits for those with higher incomes.”

That last bit is the most deflating: it would be better to do what President Obama proposed in the debt-ceiling debate: change the measure used for inflation of Social Security benefits for all Americans to the chained Consumer Price Index for All Urban Consumers, which rises on average 0.3 percent less quickly than does the conventional CPI-U. But let’s move on.

Romney’s idea for Medicaid is block-granting it back to the states—which has, in a short period of time, evolved into the consensus conservative position on the issue. And that’s a great thing. Block-granting Medicaid will unleash a policy revolution in government-delivered health care, similar to that unleashed by the 1996 welfare reforms, as individual states experiment with more-efficient ways to fix the humanitarian catastrophe that is Medicaid today.

Interestingly, Romney proposes capping Medicaid growth to CPI plus one percent, which is even less than that proposed by Paul Ryan in the Path to Prosperity (CPI plus population growth). Alexis de Tocqueville is proved right once again: it’s politically easier to reduce subsidies for the poor than for the middle class.

Contours of Romney’s Medicare plan

Romney’s Medicare plan can be simplistically described as the “Ryan plan with a public option.” And that’s both its strength and its weakness. Here’s the Medicare portion of Romney’s address:

While President Obama has been silent on Social Security, his agenda for Medicare is disastrous. He’s the only president in modern history who has cut Medicare for seniors—do not forget, it was President Obama who cut $500 billion from Medicare, not to preserve it or sustain it, but to pay for his vaunted Obamacare. And he put the future of Medicare in the hands of 15 unelected bureaucrats. These bureaucrats have the power to enact further cuts to Medicare without congressional approval, even if those cuts overturn a law previously passed by Congress. President Obama’s so-called Medicare reforms could lead to the rationing or denial of care for seniors on Medicare.

Unlike President Obama, our next president must protect Medicare, improve the program, and keep it sustainable for generations to come. Several principles will guide my efforts.

First, Medicare should not change for anyone in the program or soon to be in it. We should honor our commitments to our seniors.

Second, as with Social Security, tax hikes are not the solution. We couldn’t tax our way out of unfunded liabilities so large, even if we wanted to.

Third, tomorrow’s seniors should have the freedom to choose what their health coverage looks like. Younger Americans today, when they turn 65, should have a choice between traditional Medicare and other private healthcare plans that provide at least the same level of benefits. Competition will lower costs and increase the quality of healthcare for tomorrow’s seniors.

The federal government will help seniors pay for the option they choose, with a level of support that ensures all can obtain the coverage they need. Those with lower incomes will receive more generous assistance. Beneficiaries can keep the savings from less expensive options, or they can choose to pay more for a costlier plan.

Finally, as with Social Security, the eligibility age should slowly increase to keep pace with increases in longevity.

These ideas will give tomorrow’s seniors the same kinds of choices that most Americans have in their healthcare today. The future of Medicare should be marked by competition, choice, and innovation—rather than bureaucracy, stagnation, and bankruptcy. Our path for the future of Social Security and Medicare is honesty and security, theirs is demagoguery and deception.

Romney’s campaign website has further details on the Medicare plan. Basically, it involves a some (but not all) of things I wrote about in my big National Affairs piece: indexing the eligibility age to life expectancy; means-testing Medicare benefits; and moving to a defined-contribution, premium-support system.

Does Romney’s Medicare plan involve competitive bidding?

The key wrinkle in Romney’s plan—the one that health wonks will get worked up over—is its decision to “give future seniors a choice between traditional Medicare and many other healthcare plans offering at least the same benefits.” Basically, it’s the mirror image of what conservatives fought against in the Obamacare debate: a government-run “public option” that would compete with private insurers.

Despite that ominous description, such a plan has several politically useful attributes. Romney’s plan would further rebut the already-false charge that Republicans are “ending Medicare,” because seniors would retain the option of sticking with a traditional government-run Medicare plan. In addition, unlike with Medicaid (see above), Romney does not specify a target growth rate for Medicare. Instead, he appears to propose something akin to what policy types call “competitive bidding” or “competitive pricing.” Allow me to explain.

The idea behind competitive bidding was best articulated in a 2009 book by Robert Coulam of Simmons College and Roger Feldman and Bryan Dowd of the University of Minnesota, entitled Bring Market Prices to Medicare. If Romney wins the nomination, it could become the most important health-policy book of 2012.

Basically, in competitive bidding, various private insurers, along with traditional Medicare, bid on what they will charge the government to cover a regional population (say, the population of a specific county) with the standard set of Medicare benefits. Under the Romney approach, the “winning” bid would be somewhere in between the lowest bid and the highest bid. Seniors who selected a cheaper plan than the “winning” rate could keep the savings, in the form of a health savings account. Those who selected a costlier plan would have to pay for the difference themselves.

Competitive bidding has some left-of-center fans, most notably Boston University’s Austin Frakt. It was part of the bipartisan proposal for Medicare reform under President Clinton. A form of competitive bidding was even part of Obamacare, or at least the version of Obamacare passed by the Senate. (The House of Representatives, under Nancy Pelosi, objected to the approach, and persuaded Senate Democrats to throw it out in the House-Senate reconciliation bill.)

The thinking of the Romney team appears to have been influenced by Yuval Levin and Jim Capretta, two of the Right’s very best thinkers on entitlement reform. Yuval recently wrote an article for the Weekly Standard about competitive bidding, which he calls “the confident market solution.” The idea being: if private businesses provide better, more efficient care than the government, shouldn’t they be able to prove that in the marketplace?

The difficulty of ensuring a level playing field between government and private insurers

The biggest problem with the “confident market solution” idea is that government and the private sector don’t play on a level playing field. Traditional Medicare is much larger than private insurers, and therefore has much greater power to dictate prices to hospitals and doctors. In addition, many of Medicare’s administrative costs are paid for by other government agencies, allowing a government plan to undercut its potential competitors.

Private plans do have one thing going for them: they are able to set up preferred provider networks, in which they steer their patients to the most cost-efficient hospitals and doctors. Traditional Medicare, on the other hand, is legally required to provide access to any health-care provider who accepts its fee schedule.

What this suggests is that, unless the playing field is adjusted, traditional, government-run Medicare is likely to dominate private insurers in rural areas and other markets where hospital monopolies rule the roost. Private insurers could better hold their own in large cities, and other areas where there is enough competition among the major hospitals.

It will therefore be critical for Romney to articulate exactly how he intends to level the playing field between private insurers and traditional, government-run Medicare. Just as important, he will need to explain how he intends to protect such a program from statist alterations by a future, more left-leaning government.

How much money would competitive bidding save?

One of the biggest differences between Ryan-style premium support and competitive bidding is how prices are set. The Ryan plan is a true defined-contribution plan, in which the government says “we’re going to spend X dollars, growing at Y percent per year,” leaving insurers to work out the details: presumably by increasing the degree to which seniors share directly in the cost of their care. Competitive bidding is more correctly a defined-benefit plan, in which the benefits are pre-determined, but prices are not. The government pays out whatever the bidding process yields.

Hence, whereas the Ryan plan provides compelling clarity regarding the future fiscal trajectory of Medicare, a competitive bidding system provides none. We simply don’t know how much we could save from competitive bidding. The Congressional Budget Office, as a matter of doctrine, refuses to give lawmakers credit for stimulating changes in beneficiary behavior. As Yuval explains:

Why, then, did Ryan not propose this form of the premium-support model himself? The reason seems largely to be that the “scoring” conventions of the Congressional Budget Office made it impossible. Put simply, CBO refuses to estimate the effects of competition on prices​—​or indeed the effects of any policy on the behavior of consumers or providers. The agency scores only blunt changes in funding, but does not make economically informed projections about dynamic effects. So while CBO is perfectly happy to offer a (perfectly meaningless) projection of what the unemployment rate will be in the year 2083 (5 percent, by the way), it declines to assume that having insurers compete for customers will result in lower costs than having the government pay a universal preset rate for every medical procedure. The agency has acknowledged that its failure to account for such market effects is, as its director has put it, “a gap in our toolkit,” but it has so far not sought to fill that gap.

Other government analysts, like the actuary of the Medicare program, do model market effects, and have found that a premium-support reform would significantly reduce costs and improve efficiency. “It can get you to the lowest cost consistent with good quality of care,” the program’s chief actuary, Richard Foster, said at a congressional hearing in July. But because CBO does not score market effects, it cannot score a version of premium support based on competitive bidding. Because budget resolutions in the House of Representatives need to be scored by CBO, Ryan had to employ a preset spending level. The Rivlin-Domenici panel also wanted a plan that CBO could score, and so proceeded along the same lines.

Coulam, Feldman, and Dowd estimate that competitive bidding could shave 8 percent off of Medicare spending: a modest amount, given the program’s rapid growth rate. In the late 1990s, the City of Denver implemented a Medicare competitive bidding demonstration project, and found that bids came in at 25 to 38 percent below those of traditional Medicare. Unfortunately, that demonstration project, like nearly all others of its type, was shuttered due to fierce opposition from interest groups opposed to competitive pricing: hospitals, doctors, and other providers of medical supplies and services.

The bottom line, however, is that a competitive bidding bill won’t be credited with any savings by the CBO. Maybe this is a good thing politically, maybe it’s not. And it’s still not clear what exactly Romney is proposing, since he states that his plan is a “defined contribution” one.

Parting thoughts

It would have been nicer, and simpler, if Romney had endorsed the Ryan plan, or something close to it. (Rick Santorum and Jon Huntsman have endorsed the Ryan plan full-stop, though you could be forgiven for not having noticed.)

But it’s important to give the man his due. Romneycare 2.0 isn’t a comprehensive solution to our Medicare problems, but it does stand as a useful first step. While important details are missing, Romney has put himself squarely in the fight on entitlement reform. The former Massachusetts governor had been a laggard on fiscal issues. This plan helps him keep pace. And Paul Ryan himself has praised Romney’s proposal. “It shows we’re all singing from the same hymnal,” Ryan told Robert Costa of National Review. “It shows me that he’s willing to be bold and specific on the big issues of the day.”

And let’s not forget the two areas where Romney has set himself apart from the field: his extensive policy knowledge, and his superior debating skills. It’s unclear how well other candidates could articulate free-market health-care principles in a general election. Romney, Bay State baggage and all, can make the case.

UPDATE 1: David Brooks calls Romney “The Serious One” in the New York Times, and praises Yuval’s influence on the campaign. Yuval himself says he’s “very impressed” with Romney’s plan. The Wall Street Journaland National Reviewboth praise Romney in editorials. Austin Frakt agrees with me that the proposal lacks important details. Kaiser Health News’ report on the Romney plan is embarrassingly inaccurate.

This passage from Brooks’ piece harmonizes with what I’d been hearing from various insiders as to how Romney’s proposal came about:

The country can’t wait another four years to address this problem. A few weeks ago, Romney seemed to realize this. He sent out senior policy aides and close advisers to harvest the best entitlement reform ideas from the conservative policy johnnies. The experts were impressed. The Romney campaign operates like a smooth-running White House, with a process to identify the core issues, cull ideas and present options to the candidate.

So I remain skeptical about this scheme’s ability to rein in costs, and find the reflexive view that markets can work well with the over 65s and healthcare to be more wishful thinking than reality. A seventy-year-old with faltering memory and a ruined hip is not likely to be the most ruthless consumer – if only because he has no expertise to judge the options for him. I feel lost half the time.

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Some interesting proposals. I believe competition is the key to controlling healthcare costs and the competitive bidding feature is necessary to adequate competition. Why doesn’t anyone talk about reforming the industry to eliminate the insurance and other provider monopolies? Many changes are needed besides just costs. Why do I have to run all over town to see all my doctors? Why can’t Doctors organize to serve the whole customer, medical, dental, mental health, etc. and provide you with a consolidated bill when you go to the hospital. Healthcare USA offers very minimal patient-oriented service to patients.

Anyone else think of a Ponzi scheme when he mentioned slowly raising the retirement age for the next generation (Here is a hint, it means you will never qualify if you over 50 at the least, probably 60). The whole idea is that you pay in in order to be payed back during retirement, yet they will be taking from the current generation with the intention of never paying them. Almost fits the definition to a t…

For the past 70 years Social Security has been a pretty good investment based on the return in benefits exceeding the amount paid in for most workers. This justified having an earnings cap on the FICA tax. Now, however, as Republicans move to make Social Security more of a welfare program with means testing, raising of the eligibility age and the lowering of benefits they are eliminating the justification for any FICA earnings cap. Essentially the FICA tax is becoming just another regressive income tax on wage income. Why should a 100k per year worker or small business be in a significantly higher tax bracket than someone making millions per year? Today there is no such earnings cap on the Medicare or Medicaid portion of the payroll tax and the same should apply for the Social Security tax portion. The payroll tax is in essence the perfect flat tax.

Medicare needs to be seriously restructured if it is to become a sustainable program. Heritage’s Saving the American Dream made a proposal where individuals could choose premium-based Medicare fee-for-service. Contributions would be income-adjusted (like in Part D), restoring Medicare to its original function as a genuine social insurance program. If it could work for Part D, it could work for all of Medicare. In this way, very wealthy seniors would benefit from access to an insurance marketplace where they could not be denied coverage, but they would no longer receive taxpayer subsidies to purchase coverage. At the same time low-income seniors would continue to receive additional aid under Medicaid if they remain in traditional Medicare; if enrolled in a private plan, states could “top off” the federal contribution with further financial assistance. Furthermore, costs would be controlled in part through competition. The federal contribution for premium support would be based on bids submitted by participating plans to cover traditional Medicare benefits, as well as a new catastrophic care benefit. Bids would be weighted based on enrollment and once fully implemented, the government contribution would equal 88% of the lowest premium bid. This would put pressure on insurers to bring costs below their competitors (http://eng.am/mXvu4b).